I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

Why You Should Learn to Love the Deficit: Federal Budget Fallacies

I’ve made eleven contributions to Forbes.com so far, over half of which were aimed directly at correcting misconceptions regarding the debt and deficit. Nothing could be more foolish right now than policies that reduce government spending or increase taxes. We have nearly 14 million unemployed people in the United States, a number that undoubtedly underestimates the true magnitude of the problem since it ignores discouraged workers and the underemployed. Despite this, Messrs. Obama, Ryan, and Geithner tell us that we need to make sacrifices. Seriously? The American people already have, and what they are asking us to do will simply make it worse.

And so, I’m writing on this issue yet again. There won’t be anything new here, but I want to organize it in a slightly different manner. I’ll begin with a very general background, then offer a list of popular fallacies, and close with some pointers to more resources.

BACKDROP

Understanding the role of the federal budget requires knowing a little something about the macroeconomy. Most critical is the fact that the private sector is incapable of consistently generating sufficient demand to hire all those willing to work. This is in spite of being able to produce enough output for everyone to enjoy–in fact, it’s partly because of it. A detailed explanation is offered in this post, Why Recessions Happen, but for here suffice it to say that if 90 people can produce a sufficient volume of goods and services to satisfy 100 people, then why would the private sector hire all 100? It wouldn’t, and those without jobs must go without the output that we are nevertheless able to produce for them. The unemployed lack the income that would make the production of those extra goods and services profitable.

This is where the government can play a useful, indeed vital, role. They can supplement demand by employing the unemployed as soldiers, sailors, airmen, marines, teachers, firemen, police officers, etc. Because we started at a point of less-than-full capacity, private sector workers give up nothing, entrepreneurs earn extra profits, and it creates a series of non-market services (national defense, fire protection, education, etc.). It is truly a win-win situation, which is possible when we have idle resources. And the funds to finance these activities should come from deficit spending. There is no point in taxing away spending power from the private sector in order to create demand from the government. That’s self-defeating.

This is the essential role that only the government can play, for only it can create demand from thin air. There is no other alternative if we want capitalism to survive. Should we seek to limit government power? Absolutely, just as much as we should do so with those mega-corporations that are dominating the private sector. But a modern capitalist economy without public sector demand will fail.

POPULAR FALLACIES (in no particular order)

When the government spends in deficit, that means I am being taxed more: I’ve heard this one numerous times and it’s very obviously false–the fact that you are not being taxed to cover the spending is WHY it’s a deficit! If taxes were rising along with the spending, then it would be a balanced budget. Does it mean taxes may rise in the future? It shouldn’t. In fact, if the deficit does what it’s supposed to, then the economy grows and the deficit automatically shrinks (as tax revenues rise and government spending for unemployment and income assistance falls).

Cutting the deficit by reducing spending puts money in my pocket: This ignores the fact that a) you weren’t being taxed to finance the deficit in the first place (or it wouldn’t have been a deficit) and b) government spending is money in someone’s pocket. Thus, cutting the deficit by reducing spending removes money. This is true even if you are in the private sector, since those government employees bought groceries, paid rent, went to the mall, etc., etc. They earned income for you by buying what you sell.

You can’t spend your way out of a recession: Of course you can. We did it in the Great Depression, Reagan did it, and it’s what we should be doing right now (instead of bailing out the financial industry, wasting time with Quantitative Easing, and trying to balance the budget). Why this works should be obvious from the backdrop offered above. Businesses will regain confidence, consumers will spend, and banks will loan. So, yes, you can spend your way out of a recession because a recession is caused by lack of spending.

Cutting government spending frees up resources for the private sector to grow: It might do so if we were already at full employment and using all our productive capacity. However, in the midst of the worst recession since the Great Depression, this argument holds no water whatsoever. We have plenty of idle resources, the private sector is simply choosing not to employ them. There is no need to free up something that is already in excess supply. Nor is there some web of regulations and taxes that is preventing recovery. The past thirty years has been a continuous deregulation of our economy and effective tax rates as a low as they have been since before World War Two.

The debt has never been this large: The proper measure of the size of the debt is relative to the size of the economy. Gross Domestic Product is typically used as the gauge of the latter. Even the most extreme measures of where it stands today puts debt/GDP at less than 100%. It reached it peak during WWII, when it was around 120% of GDP. The 1950s were , incidentally, hardly a period of economic Armageddon.

We have largest debt in the world: According to the CIA Factbook, as of 2010 we ranked 37th. That put us behind the world average, Spain, The Netherlands, Austria, the UK, Israel, Germany, Portugal, France, Ireland, Belgium, and Japan.

The debt must be repaid: We must, of course, meet the “monthly payments,” but the level of debt need never be zero. The government has an infinite life span, so there is no day of reckoning when all debts must be settled. And since the debt is owed in dollars, there is never any question that we have the ability to repay since we are allowed to issue brand new ones at any time. Nor is this necessarily inflationary, as explained in the next fallacy.

Deficit spending could create inflation: Yes, it could, if we were already at full employment (unemployment around 4%). In that case, the government would be competing for resources in an economy where no excess existed–that might drive up prices. But we are a long, long way from that right now. Furthermore, inflation is a far more complex phenomenon than most people understand. For more on how inflation really works, see here:

Government surpluses help the economy grow: In fact, surpluses represent a net drain on private-sector income. Think about it: what would happen if the government spent zero but still collected taxes? That’s what a surplus is, an excess of tax revenues over government spending. We would be bleeding wealth from the private sector and giving it to the public sector. Economic growth creates government surpluses (because tax revenues rise and public support spending falls), not the other way around.

The US could default: Every penny of US debt is owed in a currency we are legally permitted to print. There is ZERO chance that we could be forced to default. We may choose to do so (just as a person in a room full of food could choose to starve), but that would be foolish. Note the strong contrast with Greece. They could, indeed, default, since they owe their debt in a currency they don’t control (there are, incidentally, many other reasons why the US and Greece are not analogous, but this one is key).

Quantitative Easing represented government deficit spending: These two are fundamentally different. Deficit spending creates new income by having the government pay for goods, services, and resources using the Treasury Department’s checkbook. Quantitative easing was meant change the form in which financial assets were held in the banking system so that it would easier for institutions to loan money. It created absolutely no new income whatsoever, which is why it was an utter waste of time. The problem was never that banks didn’t have money to loan. It was (and is) that everyone is too scared to borrow.

China controls our economy because we owe them so much money: It must be made clear that US debt to China has nothing to do with the federal government budget deficit and everything to do with the trade deficit. Even if the US government were in surplus, we would owe as much to China because our debt to them is simply the difference between how much we exported to them and how much we imported from them. They then take those excess earnings and use them to buy financial assets. That we had large budget deficits only served to make a particular financial asset–Treasury Bills–available to them in large quantities. We never needed China to buy these to finance the deficit because (in a roundabout fashion) we could always have monetized debt (i.e., sold the Treasury Bills to the Federal Reserve for brand new cash–see above for why this is not inflationary). The one thing we still don’t import from China are dollar bills! If they wanted all the money back tomorrow, we could just print it up and ship it over. China does not own the US, and they desperately need us to grow if they are going to make it because they have very little domestic demand to generate growth and are dangerously dependent on exports.

FURTHER RESOURCES

Explaining all this is so difficult because people already have in their heads that government budgets are analogous to their own. This is false, but it takes time and patience to explain why. Thus, while I hope you found the above interesting, you may want to read these, too. They represent more pointed and extended discussions of the issues we face.

This is the first piece I wrote here and is the most comprehensive treatment I have done:

I’d like to apologize in advance for the fact that I am simply not going to have the time to devote to answering comments that I usually do. I’ll do my best, but I have to start being more selective. I have too many other obligations, not least of all to my family! Speaking of which, I would also like to take this opportunity to publicly thank my wife, Melanie, for her help, encouragement, and patience with this project. She has read over many of these entries for me, pointing out where I was wrong and when I was unclear. Thanks, babe.

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Comments

Wow! When did I say directly buying? And why does it matter? Directly, indirectly? You yourself in a previous post suggested that they could do it quite easily indirectly. And now your amazed that it might be so? You’re a master of double speak and nonsense.

Yes, by all means, let’s leave it up and see what the Keynesians have wrought.

It’s double-speak to you because you don’t understand basic monetary operations. The article I attached referenced a bond auction. I was trying to illustrate that while you think dollars are becoming worthless, people are actually flocking to them at minimal interest rates. You then replied “Gee, I wonder who is buying them? It could be the government could it? It can’t work. What can’t work, won’t.” That means you think the Gov’t bought the bonds in the auction- ie directly. That’s illegal, against the law, never happens, it doesn’t work that way. Indirectly would be the Fed purchasing bonds after they’ve already been issued, such as in standard open market operations or QE.

It is double speak because it doesn’t matter whether they are buying them directly, or through a CIA front in Ouagadougou. The result is the same. It is counterfeiting. It is intentional debasing of the currency. My quote doesn’t mean that the government is buying directly. It means they are buying intentionally to effect the outcome of the auction and the value of the dollar. And you know that they are. You are trying to make a technical distinction that isn’t relevant. You sound like a defense attorney trying to get your client off on a technicality because you have no valid defense.

You’re hopeless. I want to help you understand things better, but it’s just wasting my time at this point. All you do is make assertions with no support behind them, and that’s because you don’t have any. Everything is just printing money and inflation to you. And please don’t reply with examples of Zimbabwe, Weimar, etc. What happened in these places is so different to what is happening in the US today (operationally, politically, economically, etc.) in so many ways, but I know all you will see is that money was printed. And to you, if money is being printed today, then the outcome here will be the same or similar. You’re not open to clarifications and deeper understanding. BTW, I’ll rid you of your dollars since you think they are worthless.

I’m sorry that you feel that you are wasting your time. But your “this time it’s different arguments” don’t warm the cockles of my heart. My arguments, however, have all of recorded history behind them. Fiat currencies have always and everywhere moved toward their intrinsic value. Our differences, lie not is some issue of policy, but in the fundamental principles upon which an economy can stand. Your mission, should you decide to accept it is convince me that dishonest fiat currency is preferable to an honest time tested store of value. That lies and deception in policy are preferable to honesty and integrity. That a ponzi schemes are preferable to honest investment. And that profligate spending and living at the expense of others is preferable to being productive and providing for your own future and that of your family. When you have convinced me of these things, then we can move on to the details.

For our amusement and enlightenment you might begin by explaining to us how Geithner circumvented the issue of the debt ceiling earlier this year.

Umm, my preferred store of value is silver and real estate. If you have some you would like to exchange for the few worthless dollars I have, perhaps we could arrange a trade.

“When you have convinced me of these things, then we can move on to the details.”

That’s the entire issue. You will not understand my viewpoint if you aren’t willing to build bottom-up with the details. You have already created a completely pessimistic view of our monetary system, decided fiat “dishonest,” you already are convinced govt policy is a “lie” and a “ponzi scheme,” that we are putting the “future at risk,” and your views of many fiscal and monetary policy are misconceptions, etc. But it doesn’t matter to you because you are 100% convinced of these things and won’t hear anything else.

So it’s pointless for me. It’s like me trying to explain to you 1+1 =2, but in your world you have already decided 1+1 = 3. It’s impossible. The dialogue will never work. You have created a brick wall around your mind.

BTW, I am not trying to argue fiat is definitively better than a gold standard. That’s fine if you believe a gold standard is better. And I am not trying to argue hyperinflation is impossible in the US.

What I am trying to explain is that if you want to understand the CURRENT crisis, you have to view things within the proper economic construct and historical/political context. That is, the analysis would differ if we operated a gold standard, or a fixed exchange rate, or held foreign denominated debt, or were part of the EMU like Greece, etc. And if you understand the details, and the operations and purposes of various fiscal and monetary tools, then it is completely irrational to conclude current deficits and debt threaten hyperinflation (as the vast majority of economists would agree, even those who disagree on more general economic frameworks).

Who knows- maybe WW V happens in 50 years, or maybe even tomorrow, and somehow decimates our economy and leads to hyperinflation. Or maybe somehow our govt becomes so corrupt, we end up mismanaging our economy like Mugabe did in Zimbabwe. Fine, that’s theoretically possible, and maybe you will preserve wealth with silver in that scenario (maybe we figure out how to synthesize precious metals by then too!). But that has nothing to do with today’s problems and is not remotely similar.

You are largely correct here. Except that it is my world where 1+1=2 and you are trying to convince me that it is 5 or 10 or 4 Trillion. What is dishonest is dishonest, no matter what euphemism you use. In my world, you can’t have something for nothing.